Blanket Fort Investing

Aug. 2, 2012 3:43 PM ETby: Skyler Greene

You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. - Warren Buffett

Everyone involved in the stock market generally falls somewhere on a continuum between "trader" and "investor." While most people do a little of both, if you take an average of the aggregate data of someone's activity, they're generally going to be more of a trader or more of an investor.

Traders obviously follow the news like a hawk, while investors are often cautioned to ignore the headlines. But in truth, an approach somewhere between the two extremes is probably warranted - long term investors don't need to read every headline, but should probably review relevant data and important developments every once in a while. Ideally, investors in it for the long term (for example, those saving for retirement using dividend growth investing) should find some sort of happy medium.

My analogy for determining that happy medium is building a blanket fort, something the current generation of iPhone-addicted twerps may never do. I built a lot of those when I was a kid, especially on rainy days - they were fun. They gave me and my friends a place to hang out. The best part was that all the noise was filtered out - the newscasters on the TV, the sound of the dishwasher, the sound of my parents talking about boring adult stuff like the stock market. (I mean, who would ever want to worry about a bunch of crooked lines when there are cool things like frogs and rocks to play with, right?) Sitting inside a blanket fort, my friends and I were sheltered from such trivialities, free to do about whatever it is that seven year olds do.

The blanket fort was nice, but it didn't completely remove me from the real world. When there was a lot of noise - for example, when my mother found the frog that I'd been trying to keep as a pet - well, let's just say I still heard it in time to run out the back door.

This is exactly what retirement and other long-timeframe investors should be looking for: a mindset that shields them from the daily grind, but doesn't prevent them from noticing big trouble when it occasionally comes around.

Determining What's News and What Isn't

Just because something shows up in Google News doesn't mean it's material to investors. Keep my opening quote from Warren Buffett in mind - as long as your thesis and data are both still correct, you should have conviction in your holdings. Here are some examples of "noise" that should be filtered out by your virtual blanket fort:

Analyst opinions, upgrades, and downgrades. It's important to realize several things about analyst opinions. First, reading various analyst opinions is often useful for evaluating turnaround candidates or other unfamiliar businesses. However, for the long-term investor - especially one who already holds a stock - analyst opinions are rarely material. It's important to remember that Wall Street analysts are generally focused on maximizing short-term profits, rather than long-term returns, which is what dividend growth investors tend to care about. Most analysts were bullish on tech stocks in the late '90s, while value investing was dead. Acclaimed value investor Donald Yacktman saw his AUM plummet from $1.1B to a mere $69M - pocket change in the mutual fund world. Yet, as analyzed by William Smead in his excellent piece The Price of Glamour, value investing dominated in the coming years, even in a bear market.

Disappointing earnings due to uncontrollable factors. If Coca-Cola (KO) reports that commodity costs and currency fluctuations hit earnings, so be it. The trader might be concerned and scream "sell sell sell," but I don't see anything that makes me, as an investor, think the same. Is my thesis/data still intact? Well, despite the Euro crisis and soft-at-best macro backdrop, people are still drinking Coke. The world population is still growing, meaning there will be plenty more Coke drinkers in future generations. There are still millions and millions of people in developing nations coming out of poverty and, for the first time, earning enough to afford "luxuries" like Coke, meaning there will be plenty more Coke drinkers as a percentage of the growing global population. Long-term, one bad earnings report for Coke or a similar blue chip amounts to little more than a blip in the long term uptrend.

Stock price fluctuations. If you're planning to hold for the long-term, daily, weekly, and even yearly stock price are irrelevant if you already hold the stock. (Obviously, price/valuation are important if you're looking to buy.) There are so many things that influence stock price - investor sentiment, macro factors, etc - that a short-term stock chart is often a very poor predictor of future performance. Between September 2008 and October 2008, Coca-Cola dropped by 20% when the market as a whole took a nosedive. Was Coca-Cola any less valuable in October 2008 than it was in September 2008? No.

Macro problems. Yes, the economy's a little slow right now, but you're at as much risk of losing out on a big rally as you are on getting hit with a big dip. Besides, if the stock offers dividends, occasional dips can actually be good for you. Retirement investors have no business trying to time the market and shift individual holdings around. That's a trader's game, not an investor's game.

On the other hand, certain news is relevant to the long-term investor, and your blanket should be thin enough to let these through. Here are a few examples:

Major M&A activity. With many major companies, you will have the occasional minor acquisition or spin-off, which shouldn't trouble you. But if the event is big enough to fundamentally and significantly change the company - for example, Procter & Gamble's (PG) acquisition of Gillette, or ConocoPhillips' (COP) spinoff of Phillips 66 (PSX) - should always be analyzed thoroughly. In the case of spin-offs, a business that offered safety through diversification may not be as attractive on its own. On the other hand, in the case of acquisitions, a "strong" company might be diluted by the acquisition of a less desirable company.

Potentially disruptive technological changes. Again, we're talking major here. Intel (INTC) shrinking processor die size is fun, but it doesn't count as disruptive. I'm talking about major changes, like the Apple (AAPL) iPod or Ford (F) Model T, which did in CD players and carriage manufacturers respectively. If self-cleaning clothing ever develops to the point where it becomes a big thing, I'm not so sure I want to hang onto companies making detergent. (For an interesting analysis of the common buggy whip analogy, see this from Techdirt.)

Major company problems, like Enron. Since this should be fairly obvious, I won't go into it in depth.

Conclusion

You'll notice that my thoughts on what counts as important and non-important news mirror Buffett's statement. If something happens that drives a major spike through your data or reasoning, you obviously need to sit up, pay attention, and get out while the getting's good. However, daily wear and tear is utterly irrelevant. Fluctuating public opinion means nothing if you're confident that your thesis and data are still solid. And if you're wrong, well, you're wrong - but the good news is, if you're going with blue chips, you're gonna be okay anyway.

So if you're an investor saving for retirement or anyone else with a similarly long timeframe, build yourself a nice blanket fort. Make sure you have enough shelter to ignore daily noise, but thin enough walls to hear a major whoopin' coming your way.

Let the comments begin. As an investor, how do you differentiate between "irrelevant" and "relevant" headlines?

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